Vahid Salemi / AP Photo

article

The Oil Wars

The alleged Iranian plot to blow up a Saudi ambassador is only the latest in an ongoing economic war using oil between the two countries. Andrew Scott Cooper on the unlikely roots of this battle—and what might happen next.

10.13.11 5:00 AM ET

The alleged Iranian plot to blow up Saudi Arabia’s ambassador in Washington made for blazing headlines even as it obscured a deeper truth: Iran and Saudi Arabia have been engaged in a different sort of war of attrition over the past few decades, with economics, not explosives, the weapon of choice. Both regimes are keenly aware that although bullets may kill, they can’t bankrupt: only a sudden collapse in oil revenue can do that.

Skeptics who find it implausible that the oil markets can be harnessed as a weapon, and that oil can be turned into a financial super bomb to destabilize a national economy, should heed the words of a leading member of the Saudi royal family. Prince Turki al-Faisal, previously his country’s head of intelligence and ambassador to Washington, has long enjoyed a reputation for frank talk. Three and a half months ago, he delivered an address to a select group of NATO officials at an air base deep in the heart of the British countryside. In his remarks, the prince fired a shot across the bows of the Iranian regime.

This past year, the Saudi royal family was caught off-guard by the Arab Spring uprisings and badly shaken by the overthrow of old friends and allies in Egypt and Tunisia. The Saudis blame their neighbor Iran for inciting and stoking the troubles as part of a sinister plot to divide, weaken, and eventually topple the region’s conservative Sunni monarchies. Prince Turki made it clear that after six months of being on the defensive, the Saudi royal family had rallied and was about to fight its corner by unleashing the most powerful weapon in its arsenal: the kingdom’s massive oil reserves.

The Islamic Republic of Iran, jeered Prince Turki, was “dysfunctional,” a “paper tiger,” though one with “steel claws” whose survival depended on its ability to cash in on high oil prices “to maintain a level of economic prosperity that is just enough to pacify its people.” The implication was that Iran’s reliance on a single revenue stream to prop up a sclerotic political structure had left the regime in Tehran vulnerable to sabotage.

The Saudis, continued Prince Turki, were quite prepared to use their swing power as the world’s biggest oil producer to “squeeze” the Iranian economy. They could presumably do this by opening the spigots to flood the market with cheap oil, enough cheap oil indeed to force prices down and deprive Iran’s rulers of billions of dollars in government revenue necessary to buy social tranquility at home. Flooding the market is economic warfare on a grand scale, the oil industry’s equivalent of dropping the bomb on a rival. The prince’s threat sounds like a diabolical plot best suited for a novel--holding the world economy to ransom by manipulating commodity prices to settle scores with a neighbor--until you realize it’s been done before.

Thirty-five years ago the Organization of Petroleum Exporting Countries was paralyzed by a dispute over whether to approve a big increase in the price of oil. At that time, Iran and not Saudi Arabia dominated the cartel’s decision-making process, and Shah Mohammad Reza Pahlavi favored a double-digit oil price increase against the express wishes of the Ford administration in Washington.

Recently declassified U.S. government documents reveal that in the summer and fall of 1976, in the midst of the Ford-Carter presidential campaign, President Gerald Ford’s economics’ advisers worried that another big surge in fuel costs might trigger a global financial collapse. Three years earlier, the shah had engineered the “oil shock” that saw oil prices rocket to new highs and shook the foundations of Western prosperity. To pay their exorbitant oil bills, countries in southern Europe took out huge loans from private lenders and banks on Wall Street, including Bank of America, Citibank, Chase Manhattan and Morgan. The banks lent so much money so quickly that by late 1976 they were dangerously overextended, even as European governments were pushed closer to insolvency. The fear of Alan Greenspan and others in the administration was that Portugal, Italy, and Spain might default on their debt repayments and unleash a devastating financial contagion.

When the shah refused to forgo OPEC’s proposed end-of-year oil price increase—Iran’s economy was hurting too, and a fresh infusion of oil revenue was needed to help the government pay its bills—the White House turned to the Saudis for help. In return for a series of favors, the Saudis agreed to undercut the higher price offered by the shah and the rest of OPEC by flooding the market with cheap oil. It was a tactic that amounted to a hostile takeover of the cartel and one with devastating consequences for Iran’s limping economy.

The Saudis wanted to teach the shah a lesson—they feared his military and nuclear ambitions—but they got more than they bargained for when the abrupt collapse of Iran’s oil revenue in early 1977 destabilized the country’s economy, caused a financial crisis, and shook the political foundations of the Pahlavi regime just as popular discontent against the shah was cresting. “We’re broke,” the shah lamented when Iran’s oil production collapsed 38 percent in just nine days, the staggering equivalent of 2 million barrels of oil a day. The causes of the 1979 Iranian revolution were complex and cannot be simplified in conspiratorial terms or explained away by one or two trigger causes. Still, the Saudi oil coup against the shah was a contributing factor in the collapse of popular support for the Pahlavi dynasty and it provided a template for today’s threats and machinations.

The Saudis have always understood what we in the West cannot comprehend, which is that oil is a weapon as well as a commodity. For the Saudis, oil creates wealth, develops the economy, and preserves the power of the royal family. But oil is also their primary tool of national self-defense, a potent weapon of offense, and the key to their continued security and survival.

The International Energy Agency reported that in August 2011 Saudi Arabia was pumping more oil into the system than at any time in 30 years, a record 9.8 million barrels a day. Production fell slightly in September to 9.59 million barrels because of reduced industrial demand. What do the Saudis want? Will they keep pumping? Are they putting the brakes on? How will the alleged assassination plot influence their next move? More to the point, will President Mahmoud Ahmadinejad heed the lessons of history—or will he share the fate of the shah, the man he helped overthrow?